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House prices to stay down for 7 more years

"Transaction levels have roughly halved since the last market peak in 2007, and are 35% below the 20 year average, as first-time buyers and those further up the housing ladder struggle with tighter mortgage lending rules.

"House prices have been flat or modestly declining across the UK since 2010. This stasis is underpinned by unusual economic conditions, rather than a genuine equilibrium in the market.

"The fundamentals suggest that a further correction in prices is needed as the relationship between average earnings and average house prices is well above the long-term average."

She added: "Prices have been supported so far by ultra-low interest rates. This has resulted in monthly mortgage payments falling for some borrowers.

"But it has not all been good news for borrowers. Those with only a small slice of equity in their property have struggled to re-mortgage, given that many lenders have scrapped the high loan-to-value (LTV) deals seen before the financial crisis. Instead, lenders in general now lend a maximum of 75% LTV.

"Only a handful of deals are available above this threshold and the most competitive deals are for those who have 30% or 40% equity.  Indeed, most homeowners who do not have a 25% chunk of equity in their property must stay with their current lender, and are unable to reduce their monthly mortgage payments by shopping around the mortgage market for a more competitive deal.

"First-time buyers without a 25% deposit find it hard to climb onto the housing ladder at all, although some government initiatives, such as Firstbuy and NewBuy, have tried to open up the market to those with more modest deposits.

"The Bank of England and Treasury Funding for Lending scheme, designed to boost mortgage lending as well as the availability of loans to small businesses, has yet to prove that it is really having a significant effect on the market, although there are initial signs that mortgage rates may have fallen slightly.

"The recent Mortgage Market Review (MMR), which is likely to be implemented in 2014, underlines the fact that the current conditions in the mortgage market are not a post-crisis blip. Rather, this should be considered the ‘new normal’, and the housing market will certainly reflect that, taking years to reach the transaction levels seen at the peak of the market. We forecast only a 2% rise in transactions next year.

"As the UK economy struggles to deliver convincing growth, there seems little chance of interest rates rising any time soon. In fact, recent polls of economists show that the first interest rate rise is not expected until 2014 at the earliest, with some analysts expecting rates to stay at current levels until 2017.

"This low-interest rate environment will probably continue to put a floor under prices, signalling that rather than another sudden large price shock, homeowners face a slow erosion of real prices until the price-to-earnings ratio once again reaches more manageable levels.

"However, at some point, interest rates will rise. If they rise slowly, in tandem with a growing economy where new jobs are being created and average earnings are rising faster than inflation (this is the assumption we have used in our forecasts) the housing market can weather the change.

"But it must be noted that a sudden and unexpected sharp rise in interest rates could have an immediate effect – causing a price shock, as already over-extended homeowners are pushed past the limit.

"Such a move might also force banks, which are showing hitherto unseen levels of forbearance on bad mortgage loans, to take action, which could spur a sharp rise in repossessions, further exacerbating house price declines."

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